In the discussion of the background that follows, reference is made to certain methods. However, these references are not to be construed as an admission that these methods constitute prior art. Applicant expressly reserves the right to demonstrate that such methods do not qualify as prior art.
A 20th Century History. The availability of a fleet of U.S. citizen privately owned vessels suitable for and capable of meeting the nation's needs for the carriage of its domestic commerce and a substantial portion the its foreign commerce, that will be available to meet the nation's needs in time of war or national emergency, has been a recognized objective of national government policy almost since the founding of the republic. The twentieth century enactments of the Shipping Act, 1916, the Merchant Marine Act, 1920, the Merchant Marine Act, 1927, the Merchant Marine Act, 1936 (the “1936 Act”), and the Merchant Marine Act of 1970 (the “1970 Act”) and the Federal Ship Financing Act of 1972 (the “1972 Act”) all provide evidence of the continuing recognition of the important national interests involved.
During the twentieth century, a series of national government programs were developed to facilitate the U.S. citizen ownership and operation of U.S. flag vessels, and to thereby assist the national government in achieving and maintaining these maritime objectives. Two of the most important of these programs, a capital reserve tax deferral program, and a mortgage insurance loan guarantee program, originally contained respectively in Title VI and Title XI of the 1936 Act, were intended to assist in vessel financing. These two programs were renamed and substantially modified in the 1970 Act and 1972 Act. And, as now authorized in Chapter 535, Capital Construction Funds, and Chapter 537, Loans and Guarantees, of Title 46 of the U.S. Code, they are administered by the Maritime Administration (“MARAD”), in the U.S. Department of Transportation, and are commonly referred to as the capital construction fund “CCF” tax deferral program (the “CCF Program”) and the “Title XI” financing guarantee program (the “Title XI Program”).
Most simply stated, the CCF Program enables qualified U.S. flag vessel owners and operators the accumulate the equity for fleet replacement over a period of up to 25 years under the terms of MARAD tax deferral contract agreements, while the Title XI Program enables qualified owners and to access private sector commercial vessel financing with terms of up to 25 years matched to vessel service lives by means of MARAD contract U.S. Treasury debt financing guarantees.
When available, the CCF Program can materially shorten the time required for the accumulation of equity funds necessary for a vessel purchase and materially lessen the cash flow requirements for servicing vessel debt. Where the Title XI Program is available, the borrower's Treasury related interest rates will almost always favorably compare to the rates that can be otherwise achieved, and the 25 year maturities are well-suited for financing long-lived U.S. flag vessel assets.
Merchant Marine Act of 1970 Program. The Nixon Administration's “Merchant Marine Act of 1970 Program” (the “1970 Act Program”) was designed to provide the means for the modernization of an aging U.S. flag commercial fleet. MARAD leadership and sponsored efforts under the 1970 Act Program resulted in the construction of more than $4 billion in new U.S. flag commercial vessel construction in the 1970s, which included series production of selected MARAD approved vessel designs. The Title XI Program played an essential role in providing the long-term, low-cost financing for this construction, and was employed by a variety of vessel owner-operators and owner-lessors in financing more than 9 out of 10 of the vessels constructed. The CCF Program was used by owner-operators to accelerate vessel debt repayment and to accumulate equity for fleet expansions making use of “before tax” deferred vessel earnings. While the majority of this 1970 Act Program construction involved owner-operator purchases of vessels for their own fleet operations, some operators chose to lease rather than purchase vessels needed for their operations. In their most basic form these transactions frequently involved the ownership of the vessel by a U.S. citizen financial institution owner-lessor, with the vessel demised (or “bareboat”) chartered to a U.S. citizen operator-lessee, which then time chartered the vessel to a credit worthy end user for a period sufficient to meet the owner-lessor's credit requirements but not in excess of the Internal Revenue Service leasing guidelines.
These lease financing transactions were often characterized by the owner-lessor's use of the MARAD Title XI Program for their vessel mortgage secured debt, which was generally in the range of 75 percent to 87.5 percent. However, the CCF Program was generally ignored in these lease financing transactions because no methodology for measuring its benefits in long-term charter transactions was available.
Purchase vs. Charter. Charter lease hire payable by an operator-lessee during the initial years of a demise charter will most often be less that the debt service payments that the operator would have been required to make in a vessel purchase. However, over a vessel's useful life leasing will seldom be less expensive for a vessel operator than outright ownership and mortgage backed financing. An exception can exist in situations where the owner-lessor can make immediate use of significant tax benefits which the vessel operator cannot use, and will pass on a sufficient portion of these benefits in the form of a reduced charter hire. And, the owner-lessors ability to accurately quantify the measure of the transaction tax benefits will be critical to tax benefit pass through leasing structures.
A 21st Century Problem. In Europe and the United States the past half dozen years have born increasing witness to highway traffic congestion concerns and to the use of water transport as a possible supplement and alternative. The European Community has moved to embrace water transport for its container and ro/ro traffic on “Motorways of the Sea.”
In the United States, multiple “choke points” and miles of bumper-to-bumper traffic characterize travel on major highways that run parallel to ocean coastal waters. Everyone agrees that these coastal waters “could” provide additional transportation capacity. Successive Secretaries at the Department of Transportation (“DOT”) and reports from the Government Office of Accountability have spoken of the need for a comprehensive Federal maritime transportation program that would foster such planning.
With the enactment of the Marine Transportation sections of the Energy Independence and Security Act of 2007 (the “2007 Act”), the Congress provided the Secretary of Transportation (the “Secretary”) with the authority for such a program—to facilitate DOT and State and local government collaborations, and to attract public and private sector investment for short sea transportation (“SST”) infrastructure projects to access the potential of our Nation's ocean highways. In so doing, the Congressional sponsors recognized the importance of the CCF Program and extended its application to “short sea transportation” applications in all U.S. waterborne trades.
Acting to fulfill 2007 Act responsibilities, DOT and MARAD have initiated an ambitious America's Marine Highway program. However, the means to finance the vessels necessary to access America's Marine Highways remain somewhat uncertain. Coastal freight services designed to encourage vehicle traffic movement from the nations Interstate Highways to the new U.S. “Motorways of the Sea” will require substantial capital investments. The MARAD Title XI and CCF vessel financing support programs will be the principal focus of attention. Vessel lease financing might offer an attractive alternative to vessel purchases for such coastal start-up operations. The Title XI Program has proven applicability for vessel purchase and leasing situations, but is only available based upon authorization and appropriation legislation, that is subject to Congressional and Administration budgetary concerns. And, while the CCF Program is not budget limited, its complexity, and the difficulties involved in measuring its benefits, have almost always precluded its use by owner-lessors in vessel lease financing transactions.
Operation of the CCF Program. The CCF Program provides for the accumulation of capital necessary for the acquisition, construction or reconstruction of U.S. built vessels over a period not in excess of 25 years on a before-tax basis. This is accomplished through the deferral of federal (and in most instances state) income taxes, on income from the operations and sales of designated agreement vessels, when deposited (and income on such deposits) under the terms of a CCF Program agreement (the “Agreement”) between MARAD and an eligible U.S. citizen participant (the “Participant”).
In these Agreements the Participant commits to a scheduled program of vessel construction and reconstruction projects that will advance the MARAD program objectives. In exchange for this Participant undertaking, MARAD commits the United States government to the deferral of tax on monies Participant will deposit to finance these projects. Unlike other federal income tax benefits governed by the Internal Revenue Code of 1986, the Participant's tax benefits are contractual, as negotiated and agreed by MARAD and the Participant under the terms of the Agreement.
As drafted by the then Director and Staff members of the Joint Committee on Taxation, the provisions of the tax deferral program in Public Law 91-469 were intended to function as a self-contained miniature internal revenue code that would govern the taxation of CCF Program income in all of its complexities—as a “Swiss watch” mechanism for program income deferrals and recognition—with express provisions defining its Swiss watch relationship with designated sections of the Internal Revenue Code of 1954. In its initial publication as the amended section 607 of the 1936 Act, this single section occupied 7 full-text printed pages in the Appendix to Title 46. The follow-on implementing regulations as they appear today in Parts 390 and 391 of the Code of Federal Regulations occupy almost 50 pages, more than 20 pages of which are devoted to the federal income tax rules. These provide a regime with rules for: (i) “qualifying” income and deposits, with four deposit classes and four deposit sub-ceilings, and three deposit accounts; (ii) “qualifying” withdrawals, and “non-qualifying” and “deemed” withdrawals, marshaling rules for the variously defined withdrawals, related vessel basis adjustments and income recognition, and first in/first out and last in/first out accounting, and interest charges on tax payments; and (iii) computations of and accounting for additions to and withdrawals from each of the three accounts, year by year and over the course the vessel lives and financing transactions. When the CCF Program was introduced in the 1970s it was sufficiently complex to require tax accounting specialists in simple vessel owner-operator contexts. When the 1970 Act Program vessel ownership and operation were separated in lease financing operations, and attempts were made to optimize and then quantify CCF Program benefits, in order to provide charter hire benefit reductions, the accounting task became so complex that it was simply abandoned. In later years, subsequent attempts to develop to an accounting model that would allow vessel owners and operators to optimize and quantify CCF Program benefits have always failed.